Karnataka Bank Research Report By Nirmal Bang

Shaken And Stirred

We recently met the CEO and CFO of Karnataka Bank (KBL), Mr. Mahabaleshwara M. S. and Mr. Balachandra Y. V., respectively. The meeting helps us re-iterate, with confidence, that KBL is a bank that is making several key process improvements. (Also, see Detailed Management Meeting Takeways on page 2).

Given its outlook and FY19E/20E RoE profile of 10%/12%, KBL is a prime re-rating candidate, currently trading at 0.5x FY20E P/BV. It may, also, be noted that, as of 4QFY18, KBL has recognized as NPA the lion’s share of its stress pipeline (See results note). Also, see our Initiating Coverage Report. We retain Buy rating on KBL with a target price to Rs150, valuing the stock at 0.7x FY20E P/BV.

 The housing loan delivery model has been overhauled in collaboration with marquee consulting firm BCG. This new system has been implemented on a pilot basis in Bangalore and Hyderabad. Housing loan business in these specific branches has jumped 3x compared with the same period last year. Turnaround Time (TAT) has fallen from ~30 days to less than 7 days. Following the successful pilot, this model is being replicated pan India.

 The same loan delivery model is being extended for SME loans as well.

 While loan account opening process had been centralised 3 years ago, liability account opening process has also been centralised now.

 The Power sector stress has largely been recognized by Karnataka Bank. Of the Rs 25.71bn Power sector exposure, about 84% is PSU exposure (not at risk of default). The Rs 2.93bn NPA in the Power sector book all comes from private sector Power exposure. These are 3 accounts of Rs 1.56bn, Rs 1.19bn and Rs 0.17bn, respectively.

 Of the Rs 44.57bn Non Fund book, Rs 38.26bn (86%) are Bank Guarantees (BG) and Rs 6.31bn (14%) are Letter of Credit. There is nil exposure to the discontinued Letter of Undertaking / Letter of Comfort.

 Management expects a slippage ratio of 1% and a credit costs of less than 100 bps in FY19. GNPA Ratio and NNPA Ratio are expected to move lower to 4% and 2%, respectively. PCR would hover between 55-60%.

 To source home loans, the bank has tied up with builders, tapped DSAs and market referral agents.

 The bank has also tied up with Fin Tech entities such as aggregators to source retail loans.

 The bank has also forayed into pre-approved retail loans.

 The bank has implemented a Document Management System that is having a multiplier effect across the organisation.

 Human resource management has been streamlined. The KRAs are now well-defined with a clear reward and recognition process in place. In this AGM, a resolution to implement ESOPs across the board has been passed. The management has also decided to implemented worthwhile training programs to employees.

 Employee expenses could rise by 10% in FY19. Salary negotiation is going on at the industry level and the rise in fixed salaries could be 10% at the most. The rise in salaries in FY20 over FY19 would only be due to increment/ dearness allowance, which is minimal.

 Other opex is expected to remain broadly at the level of FY18. In fact, branches have been given the specific instruction that if the Other Opex level of FY18 is to be breached, then head
office approval would be required for the same.

 Service and other charges were revised in August 2017 and then in January 2018.

 Cost to income ratio will decline to 45%.

 The bank guides for FY20 RoA and RoE of 1% and 13%, respectively.

 Net interest margin will sustain at ~3.2% in FY19 despite rise in cost of funds.

 The bank added 1 million new customers in FY18 and will add another 1.2 million in FY19.